Portfolio deconstruction

Here's a quick look at my portfolio as of now:

~30% in cash - looking for short term plays and liquidity when the volatile markets swing in my favor

~ 30% short Europe - through ETF's / put options

~5% short the Euro/USD - Euro has had it's run up, expecting low 1.3x by the end of the year on nothing good coming out of the Eurozone.

~10% physical silver - PM's are a great store of value.

~ 25% pot pourri of hand-picked stocks that are underweight utilities and overweight non-cyclical goods & services. Net short on financials.

Plan on playing more broadly as this market is definitely headline driven. Watch out for news out of Europe, and for God's sake stop buying on the rumor and selling on the news. All positive news out of Europe coming from FT.com or The Guardian is utter nonsense, and nothing is credible unless an official is willing to put his name behind it. The half-life of rumors has died down considerably, but that hasn't helped market volatility.

If you want you can try and be nimble and take a quick profit off rumors & their subsequent refutation, but that depends on your risk appetite. Mines is currently smaller than usual, and I am looking for more convergence trades and obvious mispricings (VIX @ 25?!).

Happy trading.

The Big Three

Forget Greece for a second. Forget Italy. Forget the individual countries, and let's look at Europe more systemically. There are three issues that seem to be good flag posts for the ongoing crisis, and there can't seem to be a solution that solves all three. Addressing two of the three issues seems to starve the third of much needed attention.

Those three things are:

1) Bank solvency

2) Sovereign stress

3) Bank funding

It's interesting how when addressing bank funding and bank solvency (naked CDS/stock shorting ban), the sovereign risk seems to have blown out.

Over the next three years, ~$1.7 trillion worth of debt needs to be rolled out (either paid or kicked down the road with the issuance of new debt). An EFSF levered 4x-5x will not be able to cover such an amount, not to mention the bank recaps and continual buying of securities. A number closer to $2 trillion would be needed... but seeing as how bond auctions can barely get covered in Europe as it is now, all with extremely high yields, it does not seem like this problem is shrinking nor solved.

A Deal!

Yay! The Eurozone is saved!

Private investors have agreed to a 50% haircut on their Greek debt... but is it really a 50% haircut? As ZH reports:

• Greece has €350 billion in total debt including about €70 billion in Troika "post-petition" loans; these are untouched.
• Of the €280 billion, roughly €75 billion is held by the ECB: this, like the Troika loans, will be untouched.
• This leaves just ~€200 billion in actual debt to undergo a haircut.
• Apply a 50% haircut to this debt (ignoring the fact that of this about €35 billion is held by Greek pension funds, and once the realization that Greek pensions have been cut in half dawns upon the population, the result will be the biggest riots ever seen in Athens yet).
• Total debt to be cut: just about €100 billion.
• Hence, of the total €350 billion, just €100 billion is eliminated, most of it used to backstop and service Greek pension and retirement obligations
• €250, or the residual, of €350, the original, means 72%, or a 28% haircut.
  
• Greek GDP was €230 billion on December 31, 2010 and declining fast.
  
• And that is how a 50% haircut is "cut" almost in half

The real question is... how is this going to affect the banks that are holding on to massive amounts of Greek debt? Many of them are currently under review for credit downgrades... this will only be fuel to the contagion fire.

Opportunity Knocks

Another great chart by ZH.

What can you do with this chart? The possibilities are endless. Let me give you some background first.

This past Friday(9/30/2011) was the last day of the quarter, as well as the last day for redemptions to be filed with hedge funds. Because of the volatility of the marketplace recently, fear is drowning out greed as people are moving their risky assets to safer ones as well as hoarding cash. This means that a good amount of people want out of hedge funds, and would prefer safer investments like Treasuries (beware of Treasuries - read a couple posts below). With redemptions comes the need to raise cash to pay back to investors. Thus comes the power of this chart.

Using your own methods, you can decide what stocks will probably take a hit while hedge funds are trying to raise cash and dump stock. Realize that multiple funds will be wanting to get rid of overlapping positions, and there is a first mover advantage to this (higher exit price).

Some things worth considering are:

• Size of positions in stocks
• Liquidity of stocks (use the higher liquidity ones as a signal of selling - then short lower
  liquidity stocks)
• Past returns (hedge funds would prefer to book profits rather than cut losses - sell stock that have had positive returns as opposed to writing off losses)

I'll let you come up with your own strategy, as I have my own. I'm providing you the tools and train of thought to profit from this, please take advantage and also bounce ideas around with me.

Risks:

• Hedge funds might sel off some of one stock, but not the one you short
• Game Theory - Anticipate moves and counter them before-hand
• Liquidity - Hedge funds might not liquidate stocks that take a while to get rid of
• Dark Pools - stocks get traded off the exchange among diff funds, usually in big blocks

My guess is that there will be a lot of mixing in the dark pool, most likely at discounts that will be somewhat reflected in the price. Use quickly liquidated positions as signals for slower liquidation stocks. Stay alert, do your homework, check out implied volatilities - take advantage of cheap options.

There's a rough road ahead, let's take advantage of it!

CORN-Y

There was an article in ZH today talking about how corn futures stopped trading for the day due to massive price movement:

"Back in April, when we first discussed the hike in daily corn trading limits from $0.30 to $0.40, we had some cynical observations, namely that "inviting not only more vol (read bottom line for the business) but more margin, the CME is exposing speculators to far greater impacts from margin hikes (and drops). Which of course means a far great capacity and ability to kill any commodity rally dead in its tracks." Well, there is no margin hike today (yet), although based on today's action we fully expect one. The reason, we are currently at today's down 40 cent limit, a price of $5.925 a bushel, the lowest since July 1, and by the looks of things it will get far worse: as the chart below demonstrates right now sellers outnumber buyers by a ratio of 2000 to 1. Expect this ratio to get even bigger once the CME hikes corn (and who knows what other commodity) margins as soon as today."

With this information, I did some really really quick research and came up with a trade.

My trade thesis is:

1) With the 40 cent limit being hit (so much more selling interest compared to buying), a potential margin hike due to crazy volatility, and the retreat from commodities into cash... my guess is that corn futures prices will probably gap down again at the open.

Here is the graph of CORN, an ETF that follows the price of corn futures. If you look the last bar chart is the price movement today, and the 2nd to last is the price movement yesterday. Look at that huge gap down. I definitely think that if nothing else comes out of this, there will be a margin hike that will force selling of corn futures, lowering the price of them... lowering the price of CORN, putting any shorts in the money.

More about CORN. http://etfdb.com/2010/corn-etf-corn-debuts/

Vermont-based Teucrium Trading LLC

Teucrium Corn Fund ETV (CORN)

Like most commodity ETFs, CORN will achieve exposure to the underlying commodity through futures, in this case contracts traded on the Chicago Board of Trade. But unlike a lot of products out there, CORN won’t invest exclusively in near month contracts; assets will be split between second-to-expire futures (35%), third-to-expire futures (30%), and futures expiring in the December following the expiration month of the third-to-expire contract (35%).

There are many risks to consider in this trade, here are a few of them:

• CORN price tracking with corn futures price. (Considering this ETF is based on multiple corn futures contracts, this risk seems very small)
• Rise in the price of corn futures. Very possible with such a large gap down. This of course is the biggest risk.
• Settlement dates interfering with prices. The settlement date just passed (in Sept), and if you look at the ETF's composition, it appears that the any movement in settlement is largely offset by the proportion of long-term contracts.
• Counterparty risk. Who is Teucrium Trading? They have multiple commodities ETF's and look to be a pretty solid company. Besides, if you're shorting...

Good luck and happy trading.

Disclosure: I am currently short CORN.

Why You Should Short Bonds

There are three reasons why bonds would have a great return if you short them. They are as follows:

• The credit risk of most bonds (including sovereign bonds) is high - especially compared to their respective ratings.
• Interest rates are currently artificially low, and when they eventually rise - prices will fall (bond yield and price have inverse relationships).
• Bonds are denominated in currencies. Currencies, such as the USD, will lose a lot of value in the coming times (due to Keynesian monetary policy).

All these ideas are from Doug Casey, and he has a proven track record of being right on the condition of the economy and where it's headed.

Words of another

Here are some choice words from Rich Fisher, president of the Dallas Federal Reserve Bank, talking about the aftermath of Operation Twist:

Jan Mayen is a desolate volcanic island located about 600 miles west of Norway’s North Cape. It is the home of a meteorological and communications station manned in the harshest of winters by 17 hearty members of the Norwegian Armed Forces. If you read Tom Clancy’s Hunt for Red October, you would know it as “Loran-C,” a NATO tracking and transmissions station. In the video game Tomb Raider: Underworld, Lara Croft visits Jan Mayen in search of Thor’s Hammer, considered the most awesome of weapons in Norse mythology, capable of leveling mountains and performing the most heroic feats.

My brother Mike recently visited this station on Jan Mayen. This is the sign that greeted him.

In Norsk, it reads as follows:

“Theory is when you understand everything, but nothing works.”

“Practice is when everything works, but nobody understands why.”

“At this station, theory and practice are united, so nothing works and nobody understands why.”

Winning/Losing in the markets

Hi guys,

It's been a while since I posted, but as this is towards the end of the month... I thought I would review some of the trades I've made this month as well as provide some insight going forward.

I started this month down 30% because I got caught up in earnings announcements and decided to play a lot more earnings with a lot more capital than I rationally should have. I did not do my homework and decided to account for that by placing successively larger bets to account for my losses. In short, I began to gamble a lot. Trying to recoup losses when your portfolio was +20% for the year at mid-July really does have the psychological effect of grabbing at any string that presents itself to lift you out of the hole. Little did I know that most of the strings just had me falling further into the hole. Now that I've learned the hard way with little capital, the same reminders will come up in the future when I am investing with larger capital.

This month has been slightly different. I have stopped playing earnings (sans HPQ - which I will discuss in a future post). I decided to do a lot more reading and painting a larger macro picture and investing in broader trends rather than specific companies. As I read, I realized that even a great company in a horrible sector can lead you to bad outcomes. Thus, macro matters first, then back out the sector performance, then finally companies. Top-down approach.

One big bet this month has been the Eurozone. I have been reading significantly and following religiously on the Eurozone crisis. I have read about Merkel and Sarkozy so many times that I do literally see "Sarkozy" when they are mentioned together. That led me to short EWI and EWP at the beginning of the month. The playing out of the dramatics and the implementation of the short-sale ban has led me to take a few profits, but mostly to stay in the position - as it has really great returns, limited downside, and a great risk/reward ratio for the upside. Thanks to these two plays, my portfolio has rocketed back upwards and is in positive territory again.

Another one of the plays I've been in and out of has been gold. Instead of buying paper/physical gold, I have been investing in gold companies. The main position I like to play is the Canadian company, Yamaha Gold (AUY). They are a well managed company that usually does a little better than gold, while dropping a little less on dips (worth exploring compression trade soon).

Gold has performed marvelously over the past couple of months, and through my outlook still has some upside to it, though there might be a near-term correction. Monetary policy by printing and Eurozone worries keeps AUY in my port.

Another precious metal (PM) worth looking into is SLV. For lack of a good company with solid fundamentals and good management, I just hold the ETF. Silver had a sneaky run-up but for the most part has sold off due to possible margin-hikes and "risk-off" sentiment. I am still a holder as I feel market participants are pricing in further easing and blue skies when all the data suggests otherwise.

As for my outlook - I have just summarized it. Correction is imminent, it just depends on when. There have been multiple multiple low-volume days where the market just floats up on short coverings and High-Frequency shops running up the bids. All of last week was relatively light volume days. This week will further be light volume, sans some crazy announcement, until Friday's non-farm-payroll numbers, which IMO aren't going to look pretty. Many Federal Banks have already shown their numbers about a faltering and slowing economy... and how the Q2 GDP report could cause a 2%+ rally in the markets is anybody's guess (Don't tell me Ben's leaving the door open is the cause - QE3 had slowly been priced in during the week off bad numbers on Monday).

Europe is not looking any better. There are lots of liquidity issues going on in banks, and questions about insolvency are still lingering. CDS spreads are very wide and have lowered a little bit, but expect more widening to come. I have become a proponent of using CDS spreads as proxy for stock performance, as I think that bond-holders usually have a better gauge of the company's financials than equity holders. If they are buying insurance to cover their bonds, and the spread is going up... equity holders should be wary. While bondholders still might get back 80 cents on the dollar, equity holders get NOTHING. If CDS spreads continue to widen (which I believe they will due to liquidity constraints and ineffective leadership), look for further negative market reaction. For the limited upside on the Eurozone, it will take a long time for them to get things in order - and that will most likely require a new leadership, as current leadership (Merkel) is not likely to get the support needed for EFSF, and even if she does it's over for her political career. No one cares about the IMF apparently, as Lagarde's harsh words on the current state of affairs in Europe and US led to a world-wide rally in stocks, with greater than 2% gains in European indices.

I will end with BAC. Are they in trouble, or are they not? Apparently new facts appear every day, and I have differing views with people I deem smarter and more knowledgeable in the banking industry. I think that their settlement will ultimately cost more than $8.5b, but as my old-boss pointed out, any new lawsuits or adjustments will result in something that will be stretched out to 3 years and be settled when everyone's forgotten about it. Thus, I have changed my unhedged short position to a straddle position. Any news will move the stock significantly, as the headlines will be significant (like Buffett falling asleep in the tub and deciding that he will invest in BAC after only 24 hours to review the company's books - it takes a full team roughly 3 days to have a good picture of a company, let alone one with so many illiquid and complex assets such as BAC). So far, so good.

Markets just tanked... what now?

In case you've been living under a rock, the markets have moved significantly in the past 1.5 weeks.

Starting from last Monday, Aug 1st - the S&P 500 has fallen as-near-as-it-makes-no-difference 12%. What is going on?

Well the first reason is that US government was debating on how to raise the debt ceiling. The whole circus going on in Capitol Hill really showed you the ugly and greedy side of politics.

After the debt deal was signed, the markets didn't budge a bit as low GDP numbers and the looming possibility of debt downgrade by Moody's and Standard & Poors kept investors on edge.

ISM numbers came in and tanked the market early this week. This string of bad news was enhanced by trouble in the Eurozone, as Italy and Spain become more and more dangerous and could possibly need some life support. Italy's public debt of 130% of GDP is a very alarming figure, and the GDP figures come out tomorrow.

I don't know about you, but if I were to choose between that or the US jobs report as being a bigger mover in the markets tomorrow morning, I would say Italy's GDP by a mile. That number doesn't look like it'll please many people besides those short the market. The US jobs report tomorrow morning at 8:30am doesn't look too promising either.

There was a massive sell-off today as the VIX spiked and blue-chips were unloaded by investors moving into a risk-off scenario. Investors flocked to any safe security, including US Treasuries. For a moment, the 1M T-bill had negative yield. For those unfamiliar with the matter, that means you are PAYING the government to hold onto your cash for a month. Ridiculous. The 10-yr TIPS yield also fell more than 50%, moving inverse to the price.

What's to come?

My guess is more of a correction. Bernanke will use what's left of his warchest for QE3, but that should have the effect of a mouse coughing. Things don't look good people. The signs point to a global slow-down.

US - economic data looks weak and even though companies are beating earnings, the outlook doesn't look as rosy as it did at the beginning of earnings season

Europe - They've got their hands tied for a long time coming. Greece is barely supported, Italy is going to become a problem, Spain has some time to get things in order so long as GDP keeps growing. Portugal is being supported by Trichet and the ECB, but that can't last forever. You know something's amiss when Trichet goes against what he said he would not do in order to prop up the crumbling structure of the Euro. Godspeed to Europe.

China - Overheating. Expanding too fast, not enough infrastructure, the government is starting to strike a discord with the people. Growth is good, but China can't be a one-trick pony, and indicators are showing that the trick is getting old and consequences are starting to catch up.

Brazil - Actually, nothing too bad about Brazil. Growth and risk-on story. Look for pull-back of funds, and use that as an entry point for yield. IMO this is a better yield play that waiting it out in US equities, good luck trying to find something with decent yield in the US market.

Even gold seems to be affected, as people are selling off everything, including gold, to move into cash. I am usually contrarian, but when the smart money is leaving and risk is left on the table - that is not the time to be picking up the dice.

Retreat and live to fight another day.

What happens in this situation...

So I was thinking today, what happens when the AAA rating of US Treasuries get downgraded?

The part that I am thinking about is pension funds. They have to have an average weighted rating, and the usual pension portfolio holds some amount of long-dated treasuries to duration-match their portfolio with the duration of their obligation. So, when treasuries get downgraded to AA, the average weighting of the portfolio will thus fall. Pensions will then try and get rid of them and exchange them for AAA bonds that will push them back up to an adequate rating.

Two questions then arise:

1) How illiquid would the market become when all pension funds start dumping treasuries?

2) Are there enough AAA corporates /agencies/munis to cover the new increased demand?

The effects would then be a rising US treasury yield and a falling AAA everything else yield. Maybe play the spread?

Let me know your thoughts.

**UPDATE**

The answer to this question is that pension funds usually use and average of the 3 credit rating agencies as a rating for holding in the portfolio. Thus, this situation would only occur on the second rating agency downgrading the US (like that will ever happen), or if S&P decides to move US below A rating... which isn't going to happen either. Thus, it looks like we're safe for now.

What does it mean?

So just the other day, I decided to take a big position in a firm I was bullish about. I did my research and knew that the company was going to blow the socks off the estimated earnings. I knew further that the debt ceiling crisis had taken a toll on this stock as well as the greater market, this past week alone the stock had fallen ~ 5% and taken me from big gains to moderate losses.

Well after the close was the moment of truth. At then it hit. EPS was 22% above estimates. Actual revenue beat estimated revenues by 10%. Annual earnings revised up 40%. The stock was up 8% after hours. I had a BUNCH of naked calls. I slept well that night.

I woke up the next morning and saw that the bid/ask were nowhere near the highs of the prior afternoon. This was a stock with a daily avg volume of roughly 1 million shares, so I knew there might be some big spreads... but there wasn't. The spread was 5 cents, and it was flat compared to yesterdays close (read still down ~5% for the week). I was in disbelief.

The stock opened 1% up and proceeded to fall to -3.5% for the day, on average trading volume and no new information. I listened in on the conference call and all the analysts congratulated the company on a stellar quarter. The guidance was positive. WHAT is going on?

Well, rather stay in and find out, I got out before it dipped negative, though I lost out a lot on the costs of flat earnings when playing options. Now that I have some time to review the trade, I still can't seem to figure out what went wrong...

TTM and forward P/E are <10, good history of beating estimates, no real cost headwinds or economic slowdown forseen, CEO fielded questions in earnings call cleanly and positively, stock had been rising in the past month and had taken a turn when the impending debt ceiling had become a lot more of a reality than something to be aware of.

I still have a long-dated option in play, taking my nasty -8.5% tumbling this week. In options territory that's roughly a 20% loss. I am still bullish on the stock, and maybe I'll buy in more conservatively right after this debt fiasco is over, but this was one of those textbook stocks and textbook stories that you are supposed to tell at the dinner table - you do your homework, you're on the right side of the call, you get rewarded. Turned out not to be that way.

If you have any idea why a company (not this company in particular) would act in such a way... please give me some guidance. Thanks.

Gold is getting shinier Pt. 2

Eurozone Crisis

Congrats to Greece for getting a bailout package. An effective kick of the can down the road.

What's actually happening? Here's my understanding of it:

If you have a Greek bond that matures in a couple years, 30% of that you keep as cash, 70% gets rolled into a 30 yr Greek government bond. The coupon will be 5.5-8%.

Greece will take a portion of that 70% and put that in a "special purpose vehicle" - which will invest that into AAA govt / agency bonds - for a 30 yr 0-coupon bond.

This SPV is to guarantee the principal of the 30-yr Greek debt.

Though you might not like it, it might be shady, and what not - it's better than the current alternative. According to what I've read "More important, the accounting rules allow you to pretend that you are not making any losses at all."

What happens when that becomes unsustainable? Also, what about Italy and Spain? All this causes instability in the markets, and people look for safe investments in such circumstances. Such safe investments are the USD/US Treasuries, gold/silver, JPY/Japanese bonds.

USD might be a good investment right now, cause of the US debt crisis - lots of dollar shorts on - if stuff really hits the fan, there will be a massive short cover that will cause a significant dollar rally. However, there are multiple risks with that.

Gold is still the investment of choice for me.

Leon was right

Ladies and gentlemen. This doesn't happen often, but Leon was actually right. As we speak, shares of Google are trading at roughly 10-12% above their closing price today due to a stellar earnings report.

Shares spiked close to $600 during the earnings call and have settled down a bit now. But wow, what a party.

Gold is getting shinier

There are three big themes going on in the world right now, and a lot more other ones (not saying they're less important, but I will not be covering them in these next few posts). I will cover one topic each post... though don't expect the posts to be caulk-full of figures and cited arguments. They're still just broad strokes which can be backed up by sound logic and figures if you look/read around.

The three themes:

• US debt ceiling
• Eurozone crisis
• China's inflation

Today's theme: US debt ceiling

If you read the "guest post" on Friday, you would know how things stand on the debt ceiling. Suffice it to say that if the US doesn't raise its debt ceiling and defaults on its loans... the credit rating of the US will go kaput, and yields should rise.

Sure, USD is a supposed to be a safe haven for money as the world's reserve currency, but how safe is it when the country's government can't agree on paying back those loans? Sure we're at an unsustainable spending spree brought on by our understanding of the capital markets, but still... stop looking further down the line when you are about to shoot yourself in the foot.

What does this mean? New safe havens of money. The JPY and the Singapore Dollar look to be the favorites of the smart money, and of course things that hold universal value... such as gold. Even if the debt ceiling is raised, there will most definitely be the cautions of "having a close one", and investors might decide to take a little away from their US Treasuries safe-haven into other "safe" investments.

August 2nd is the date of reckoning. That leaves 3 more weeks to reach a compromise. What do I think is going to happen? They're going to come up with something. The US government might be obtuse, but they're not stupid. However, gold is king in moments of uncertainty... and there are plenty of uncertainties to pick from.

Earnings Season is RIGHT AROUND THE CORNER

Hello All,

Since AA　reported rather mixed earnings as of yesterday, July 12, the markets have been a bit wobbly in terms of hovering around positive and negative. The next two weeks will definitely set the tone for the rest of 2011, as Greece, Japan, and national debt crises have rocked the first half of a highly volatile year.

Companies set to report earnings within the next two weeks are reporting for the past quarter, during which many analysts believe that a cooldown has occurred since the tsunami that hit Japan in mid-March. Analysts have also had to constantly lower their estimates of EPS and revenues multiple times as many companies have lowered guidance as well.

Even in the coolest of earnings seasons, many companies have a tendency to jump in a +/- direction sometimes of almost 20%, which proves to be ripe for initiating straddles or spreads that can earn lots of money. If you want to do it, you must do it now, for the time-decay of options may have already made it to expensive for entry. I leave you with a list of the most volatile stocks after earnings as seen on a post on seeking alpha. Have fun and let's hope you bet correctly!

Most Volatile Stocks on Earnings

Guest Post (not really)

I am letting someone else take the limelight today. As much as I hope that he knows me, Mohamed El-Erian (CEO of PIMCO) has no idea I exist. But I know him, I like him, and I read his literature.

He spent an hour doing a Q&A with Reuters this morning, which was, I feel, the best hour of news I read this week. His answers to all sorts of questions are very well thought out and seemingly effortless in response. He sure knows his stuff and is willing to let us pick at his brain for our own edification.

Trust me, the twenty or so minutes you spend reading the Q&A will be better than countless hours reading my thoughts. So without further delays, here's the link to the Q&A:

http://live.reuters.com/Event/Mohamed_El-Erian_Live_QA?Page=0

Why I Think There's Going to be a Correction

Before the crash, a lot of foreign central banks bought Treasuries to maintain the exchange ratio and keep exports strong. However, since the crash, many of the foreign central banks have stopped buying Treasuries, and the burden was placed to the Federal Government to keep interest rates low by buying up all the issuances.

QE1 ended. Now QE2 has ended. Foreign central banks have not rekindled their interest in Treasuries, and the Federal Government has stopped footing the bill. So, the private sector has been expected to account for the ~$370 billion supply of Treasuries each quarter.

Well, let's think what happens if they don't?

If the private-sector demand does not match the supply of Treasuries, the yield will go up and the price of the Treasuries will go down until equilibrium.

What happens when yields go up? Interest rates go up, and the cost of borrowing goes up.

What happens when the cost of borrowing goes up? Companies cannot borrow cheaply anymore, people cannot borrow cheaply anymore, and banks don't enjoy the huge spread between the short-term and long-term yields that have been fixed in their favor.

Because of higher interest payments, a smaller piece of the pie is left for equities, and money will flow towards the higher yielding debt.

Hence a correction in the equity markets, and higher yields in the bond markets. So I would suggest you prepare for it. With the end of QE2, it is only a matter of time before the correction arrives.

Sites that you read for market information

I think today I'll share some of the sites I go to for information about the markets. I am all about reading brilliant thoughts and seeing how others are viewing the market. Some are daily reads, some are weekly reads, and some are quarterly and annual reads. Let's share resources so that we can all understand the market a lot better.

Daily:

• Wall Street Breakfast: Must-Know News on Seeking Alpha. Great source of what's going down today and what happened last night while you were asleep.
• Wall Street Journal. This one is self-explanatory.
• Zero Hedge. More thoughtful, pessimistic, and angry commentary about the current and future conditions of the markets. The comments are the best.
• Rolfe Winkler's Twitter Page. Followed him back when he was at Reuters. Now that he's at WSJ, it's nice seeing his articles come up in "Heard on the Street".

Weekly:

• Payden & Rygel: Weekly Update. Found out about this when I went doing due diligence for my interview there. Updates every Friday morning.
• Barron's. Enough said.

Quarterly/Annually/Whenever available:

• Howard Marks (Oaktree Capital): One of the best distressed debt investors on the face of the earth.
• James Montier (GMO): Great commentary, very easy to read.
• Jeremy Grantham (GMO): One of those perma-bears, but you gotta love him for it.
• Warren Buffet (Berkshire Hathaway): Shareholder letters. Read all of them. They all have great points worth noting.
• Bill Gross (PIMCO): Anything he says you have to read; everyone else does.

Hedge Fund model vs Prop Shop model

I have been talking to a couple prop shops recently, and I got a chance to sit down with the owner of a prop shop that specializes in fixed income derivatives. Since to be a part of the shop you have to put up your own capital (typically $500k to get a seat and play with the house's money), and I only have a fraction of that in the market, our conversation was more towards the prop shop model vs the hedge fund model.

The owner has spent his time around big banks, hedge funds, and prop shops - and aside from running the prop shop he is a professor at a top business school. I took lots of notes through our conversation, and I've decided to share a bit about the hedge fund vs. prop shop model.

In the hedge fund model, you are using client money to try and make more money. However, the structure is setup such that the fund manager gets all the spoils. You can compare such a hierarchical structure to those found in mail-order catalog networks and knife selling agencies. There are the work horses and the decision makers, then there's the guy who gets to decide who the decision makers are and call shots on the shots. The example I have seen used for this model is the pyramid of wine glasses, where the top glass always gets filled first before the second tier glasses get filled. Furthermore, the lions share of profits from the hedge fund model comes from not the 20% profit but the 2% management fee; getting paid just to play.

In contrast, prop shops pay significantly more based on performance. You pay to play upfront, usually contributing some form of capital to play with company money. You lose, you don't get paid; you win, you keep 35-80% of your profits depending on various factors. The owner compared himself to the house: people pay to play, play with house money, some win and some lose, but the house gets a cut off each bet. The traders get the research and execution they need, and the house gets paid. +1 Props.

Personally I don't trust hedge fund managers who don't have their own skin in the game, there's a real moral hazard there. Prop shops have the "better" model in that regard as well, as losses are shared between your self and the shop. Mallaby argues in More Money Than God that the hedge fund model is better than big banks in terms of moral hazard, and I agree, but that's not saying much. +1 Props.

After we finished the conversation, it seemed that we agreed on one thing. You should definitely go spend some time in the big banks/hedge funds to learn how to trade. However, once you know how to and are finding/making profitable trades, the prop shop model is a better alternative compared to staying in a hedge fund. That is, of course, unless you start your own fund.

The owner's approach? Find the market and become the house. As long as people are trading, the house gets paid. And the house gets paid well.

Why I bought GOOG and you GOOG too!

Greetings fellow traders!

Exactly one week ago on June 24, Google was trading at a puny $474. Fresh off of a huge end of May plummet, I decided that it was time to move in for the kill. Google, the largest search engine in the world takes up over 2/3 of total searches on the internet. With a 52-week high of almost $700, it was trading at a P/E ratio of 18. Let's break this down a little further:

As of March 2011, Google has, on-hand, $12.4 BILLION in cash. No debt, and 20% revenues in search engine growth year over year. The latest was $5.9 billion. Pretty much anyone and everyone on this planet knows what Google is. The piece of information is a dealmaker - According to current valuations, Google stock price should be valued at $663.

So I thought to myself, $474? $30 off a 52-week low? You've got to be kidding me. Now, a week later, Google has broken the 500 mark and is well on it's way to hitting $520 as we roll into this July 4th weekend. Should I take profits? I believe this stock will be rolling well into the future.

Let me know your thoughts in the comments section!

The hedging company

For the moment I am not adhering to the strict deep value strategy. I am very pessimistic about the upcoming months, and am waiting for a large correction soon. This week we have seen four consecutive days of 1% gains in the large indexes, and that is preposterous to me. I am not sure when this bubble is going to burst, but I have positioned my portfolio to be cash heavy, and all my bets have some form of hedging associated with them.

Of the portion of my portfolio that I am investing, roughly 70% of the funds are in long-dated options expiring in December or January. The implied volatilities are slightly larger than normal market conditions, but laughable when you consider how bad things can become. Thus my hedged positions also double up as volatility plays.

As for sectors, I am net long the healthcare and basic materials sector and net short natural gas.

My strategy is about relative value. Look for companies within sectors that have some momentum, good fundamentals, decent future prospects, and have lower beta relative to the sector in bad times. Holding period is 6 months, in which I will screen for new long/shorts and turnover 50% of the portfolio every 3 months. Long the company, short the sector.

Simple enough, we'll see how it performs. I turned over the portfolio to this strategy 06/28/2011, and so far I am net positive 1%. I will update regularly.